1. Understanding Interest Rates
Chapter 4
Understanding
Interest Rates

2. Distinction Between Real and Nominal Interest Rates
The Real Interest is adjusted for expected changes in the price level as given by the Fisher’s equation: r ≈ i - e
1. Real interest rate more accurately reflects true cost of borrowing.
2. When real rate is low, greater incentives to borrow and less to lend.
if i = 5% and e = 3%, then r = 5% – 3% = 2%
if i = 8% and e = 10%, then r = 8% – 10% = –2%
© 2006 Pearson Addison-Wesley. All rights reserved

3. U.S. Real and Nominal Interest Rates
© 2006 Pearson Addison-Wesley. All rights reserved